Friday, October 19

The Crash of '87

Editor's foreword:

Unlike most of the posts here, the following story describes an event that many/most of us were alive to witness. Or at least, we were alive at the time. Because to say most people "witness" things that happen during their life is to assume they were actually paying attention to something other than the personal details of their ordinary lives.

But some folks can say something like "I was actually at the ballpark when so and so pitched that perfect game." Of the following account, many of the folks my age who worked on trading floors of stock exchanges or busy trading rooms in brokers offices can say, "I was there when the stock market crashed in '87."  And I'm one of them.

When you "witness" something of that magnitude, your account of it depends somewhat on where you were sitting in the "ballpark" at the time. My story of what happened at my firm, G A Davies & Co. on the floor of the Chicago Stock Exchange on that day is fascinating. At least to me and the others who went through it, but it would be boring to most outside the securities industry.

Not so for the account of Arthur Cashin on the same event. He had a different seat than I did. Exchange wise and perspective wise. That is why his account of the events appears below instead of mine. However, I will conclude this foreword with one memory that I will never forget and which I think wraps up the consequences of the event rather tidily.

Our firm had lots of clients, ranging from small self-financed market makers, to large mega brokerage houses,  to big individual traders. The biggest trader we represented was a friend as well as a client. He was arguably the biggest stock and options trader in Chicago. His trading badge acronym was STA. (You insiders know his name.)  And like most good traders on that day his goal was not profit, it was survival.

After the incredible events of the day had concluded I had an opportunity to talk to him briefly after the close of trading. I asked him the following question. "John, are you okay?" His answer was memorable because it indicated that he had achieved what everyone was striving for. He said, "Well, I lost a bunch of money, but I have a bunch left."

And so we survived. As individuals, as financial institutions, as companies, and as a country. So enjoy Mr. Cashin's account and always remember; since the dawn of history man's biggest goal has been merely to survive. The stories of success and failure are not the norm, they are the exception. Which is why we recount them here.     Grant Davies

By Art Cashin

On this day in 1987 (that's 25 years ago, if you are burdened with a graduate degree), the NYSE had one of its most dramatic trading days in its 220 year history.   It suffered its largest single day percentage loss (22%) and its largest one day point loss up until that day (508 points).  No one who was on the floor that day will ever forget it.

While it was an unforgettable single day, there were months of events that went into its making. The first two-thirds of 1987 were nothing other than spectacular on Wall Street.  From New Year to shortly before Labor Day, the Dow rallied a rather stunning 43%.  Fear seemed to disappear.  Junior traders laughed at their cautious elders and told each other to "buy strength" rather than sell it, as each rally leg was soon followed by

One thing that also helped banish fear was a new process called "portfolio insurance".  It involved use of the newly expanded S&P futures.  Somewhat counter-intuitively, it involved selling when prices turned down.
The rally topped out about August 25 th with the Dow hitting 2722.  Interest rates had begun creeping up amid concerns of early signs of inflation.  Treasury Secretary Baker began a rather open debate with the Germans on the relationship of the dollar and the Dmark.  Soon the weakness in the market was turning into a visible correction.

By the middle of October, the Dow fell to break an uptrend line that had protected it for over 1000 points.  The flurry of takeovers and leveraged buyouts that had flourished all year began to dry up. On Wednesday, October 14th, there were widely discussed rumors of a new punitive tax on takeover profits.  Selling turned a bit ugly and the Dow fell 96 points by the close (a record point drop at the time).  The next day there was no bounce and the Dow fell another 58 points.

Friday, the 16th was an option expiration day.  There was a very bad storm in London and that market closed, which forced more people to seek liquidity in New York.  Stocks faced a steady wave of selling.  As the close neared, rumors spread that the First Lady, Nancy Reagan, the President's right hand, might be admitted to the hospital with cancer.  The selling intensified and the Dow closed down 108 points, on
the low and a new record point drop.

The weekend was a rumormonger's delight.  Nancy was admitted to the hospital.  Japan was considering a confiscatory 96% tax on real estate speculation.  Germany proposed a change in taxes on some interest rates, which would make U.S. Treasuries unattractive to Germans.  Rep. Gephardt was talking about a trade bill that would freeze imports.  Treasury Secretary Baker went on a Sunday talk show and openly challenged the Germans on currency.  There were even rumors of U.S. planes engaging Iran.

At the time, I was running the floor for PaineWebber.  Monday morning I got up well before dawn and saw that Hong Kong was down about 10% and other markets were looking equally weak before their openings.  I headed for the NYSE to check on our systems and staffing.  I reached out asking the team to get in early.
Once I had checked out the systems and verified staffing, I went with a partner up to the Luncheon Club for a quick coffee. With markets around the globe all down about 10%, I didn’t know if we’d get to a coffee – or anything else after we opened. We sat about two tables away from a table where NYSE Chairman John Phelan sat with several directors and some staff.  Every ten minutes or so, someone would rush up to Phelan and slip him a note or whisper in his ear.  It was evident that things were deteriorating.  As I headed for the floor, I went past Phelan's table, put my right arm across my chest and said – "Nos Morituri Te Salutamus Esse".  It was the gladiator's salute to the Emperor – "We, who are about to die, salute you".  Phelan nodded without a smile.

The opening was not an outright disaster, but that was primarily due to the fact that many stocks did not open immediately.  They were delayed, with indications to warn investors of the prices that they might open at (with hopes of inviting bargain hunters).  Meanwhile, in Chicago, where you could short without a plus-tick, prices headed for freefall.  Soon prices were lower in Chicago than in New York.  That brought even more selling pressure to New York.

Shortly after the opening, as it became clear that this would be a very special and very dangerous day, several NYSE directors met in Chairman Phelan's office.  They checked around the street to gauge any new trends in the selling pressure.  They were also on the phone with the White House via former Senator Howard Baker, who was White House Chief of Staff.

Meanwhile, back on the floor, the situation felt more unreal.  Orders flowed in faster and faster and the tape ran later and later.  (The tape was linear and the human eye can only recognize a certain number of symbols per second, 900 I think.  To run faster than that would make the tape an unreadable blur.  Traders can trade faster than the maximum reading speed – so the tape ran late.)  One broker said it was like a bizarre dream sequence – nothing seemed real.

In late morning there were signs that the markets might begin to stabilize.  Then the newly appointed Chairman of the SEC, David Ruder, was intercepted by reporters leaving a meeting at the Mayflower Hotel in Washington.  Whatever they asked and whatever he said, it somehow was reported that the markets might have to be halted.  Later, he would swear it was a typo but you can't un-ring a bell. The fear of a halt sent buyers scurrying away.  Stocks went into virtual freefall.

The interaction with the futures saw prices melt away.  The Dow closed down 508 points.  One specialist, who made too good a market, ran out of funds and the firm was sold to Merrill Lynch that very night.  At watering hole after watering hole, traders and specialists reported again and again how strained their resources were.  Wall Street could not survive another day like this.  Luckily, innkeepers, like Harry let them put the drinks on a tab.

What is often lost in the retelling is that the next day, Tuesday, was far more dangerous.  It was the day that the wheels almost did come off the locomotive. The Dow opened up about 200 points Tuesday to a round of cheers on the floor. But, stocks quickly turned lower.  The 200 point gain was erased and the Dow went negative, accompanied by an audible gasp on the floor.  Soon it was nearing -100 and trading was being halted in several of the Blue Chips that make up the Dow.

Then we learned that several key banks were shutting down the credit lines of market makers and NYSE specialists.  The banks feared exposure to an apparently collapsing stock market. NYSE Chairman Phelan reached out to the recently appointed head of the Fed, Alan Greenspan.  Unfortunately, Greenspan was on a plane.  Desperate, Phelan called the President of the New York Fed, Gerry Corrigan.  He sensed the danger immediately and began calling the banks to reopen the credit lines.  They were reluctant but Corrigan ultimately cajoled them.  The credit lines were reopened and the halted stocks were reopened.  Best of all, the market started to rally and closed higher on the day.

It was an incredible time and the financial system was within hours (and a few phone calls) of an absolute collapse.  It was a time I'll never forget.

Many thanks to Mr. Cashin and UBS Financial Services who graciously allow his historical musings to be republished on this site. To enjoy more of Art's posts simply click on "Cashin's Comments" in the label section on the sidebar.

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